Stablecoins and other random topics

[nycEMMD]

Ok listen up windowlickers, mouthbreathers and nocoiners alike. Lately there’s been a bunch of posts on this forum about stablecoins from people with no understanding of what they are. I’ll try to give a “brief” explanation of what stablecoins are, the different types of stablecoins, the risks and benefits of stablecoins and maybe dive a little into defi and the reasons why stablecoins offer such a high annual return at this time. This is a pretty basic summary, please let me know how wrong I am et al. in the comments below

The traditional financial system

So let’s start with brokerage accounts. I’m assuming everyone here has a brokerage account. Let’s say you want to transfer $1000 from your bank account to your Vanguard account to buy VOO. When you initially deposit this money into your brokerage account, it does not stay in there as cash. You are actually buying a share of a money market mutual fund. Examples of these funds are VMFXX at Vanguard and SPAXX at Fidelity. VMFXX is basically a mutual fund that tries to perpetually maintain it’s value at $1. It holds a combination of assets such as cash, US govt treasury bonds, CDs, etc so that it maintains the share price of VMFXX at $1. The assets that VMFXX holds might change as market conditions change but the value of each chare of VMFXX stays the exact same, $1. So when you deposit $1000 into your Vanguard brokerage account, you’re actually just buying 1000 shares of VMFXX
Here’s a list of what VMFXX holds at this time:
https://investor.vanguard.com/mutual.../profile/VMFXX
Now there are risks to keeping money in VMFXX. Although Vanguard has been able to maintain the value of VMFXX at $1 for many decades, there is still a possibility that the value could drop below $1 in the future. The money is not backed by FDIC insurance but money market mutual funds like VMFXX are tightly regulated by the SEC and have to follow a certain number of rules in order to protect investors

Why do we need stablecoins?

If we look at the traditional financial system and decentralized finance (Defi from now on), they both exist in parallel with centralized exchanges allowing for the transfer of assets from one system to another

Traditional fiat based financial system ß----à Centralized exchanges ß----à Defi

Centralized exchanges like Coinbase, Gemini, Binance.us, Crypto.com etc will allow you to deposit fiat and convert it into cryptocurrencies which can then be transferred to a Defi application in order to be used in the Defi space. The opposite is also possible where money can be taken from the defi space and converted back into fiat currencies. The system is inefficient, plagued by high fees (charged by centralized exchanges) and limited by the archaic rules of the traditional financial system.

So what happens if you want to move into cash or a cash equivalent asset without leaving the crypto space?

Enter stablecoins

Stablecoins (SC from now on for simplicity’s sake) are cryptocurrencies that are pegged to fiat currencies, most commonly the USD. Think about SCs as the money market mutual funds of the crypto space. They do the same thing as VMFXX. They hold a basket of assets that allow the value of the SC to remain at $1. This allows people to remain in the crypto space while holding USD equivalents, therefore avoiding the high costs of moving between USD and crypto

Examples of different SCs

Before we dive deeper into the assets that are used to back SCs, here are some of the most popular SCs:

-USDC: was created by a partnership between Circle (a defi lending platform) and Coinbase (a centralized exchange). Probably the one SC that most people in the US know about simply because coinbase is the most noob-friendly platform

-GUSD: created by Gemini (a centralized exchange). Gemini was founded in 2014 by the Winklevoss twins (hence the name gemini). Remember them? They got a bunch of money from the Zuck after they successfully sued him for stealing the idea of Facebook from them. They used some of that money to buy BTC early and then founded the exchange in 2014

-BUSD: created by Binance (a centralized exchange). The biggest exchange worldwide, credited with popularizing crypto globally

-USDT: You will often hear people refer to USDT as Tether, one of the earliest SCs and the biggest stablecoin by market cap. There are some specific risks associated with Tether which we can discuss further below

-DAI: a crypto backed SC created by MakerDAO.

-UST: the SC of the Terra/LUNA ecosystem. It is an algorithmically backed SC

"OMG you forgot to mention my favorite SC, KittyElonUSD, OHHH MAAAHHHH GAAWWWDDD" I don't care but please tell me about it in the comments

Types of SCs

We saw in the link above what assets were used to back VMFXX and maintain it’s peg to the USD. So what assets are used to back SCs?

-Fiat-backed SCs: These are the most popular SCs. They are the exact crypto equivalent to VFMXX. They hold fiat-based assets such as cash, US govt treasuries, CDs, etc in order to maintain their value at $1. Examples of Fiat-backed SCs include USDC, GUSD, BUSD and USDT. For example, when circle/coinbase wants to create 1000 USDCs, they have to acquire $1000 worth of assets to back it up.

-Cryptocurrency-backed SCs: These SCs are backed by cryptocurrencies instead of fiat-based assets. An example of a cryptocurrency-backed SC is DAI. It was initially created in 2017 by MakerDAO (a decentralized autonomous organization, hence the DAO in its name) and was only backed by ETH at that time. It is currently backed by a bag of blue-chip cryptocurrencies including BTC and ETH. Cryptocurrency-backed SCs are generally overcollateralized which means that the value of the cryptocurrencies being held is worth more than 100% of the value of the SC, usually closer to 200%. So let’s say the price of ETH is $1000. If we want to create 500 DAI, we would have to deposit 1 ETH as collateral to back those up. The risk with cryptocurrency-backed SCs is that if the value of the cryptocurrencies that back them drops significantly, they could eventually lose their peg to the USD and could drop in value below $1

-Algorithmically-backed SCs: There are no hard assets backing these SCs, no cash, no treasuries. They are backed by an algorithm that maintains their value at $1. An example of an algorithmic SC is UST. It was created in the Terra/LUNA ecosystem. It’s important to note that there has never been an algorithmically backed SC that has succeeded over a long period of time and most of the attempted ones eventually lost their peg and failed. One of the holy grails of Defi is finding an algorithm that can create an algorithmic SC that remains stable over a long period of time. The current contender is UST. Some of the advantages of algorithmic SCs is that they can provide infinite liquidity to growing markets (like the FED is doing right now) and can separate the value of SCs from fluctuations in the underlying assets (fiat-based assets or crypto-based assets) that are used to back the other 2 categories of SCs described above. They are also void of censorship and cannot be blocked by a central authority.

Advantages of SCs over Fiat

- Reduced cost by not having to move between the crypto space and the traditional financial system back and forth

- Reduced volatility, able to take profits in the crypto space

- Instant settlement, no need to wait for the 48 hour rule present in traditional finance

- Near instant transfer between exchanges and to and from defi apps

[nycEMMD]

Risks with SCs

If I buy UST, what if the algorithm fails and its value goes below $1?
That’s a risk with algorithmic SC, if you don’t want to take that risk, stick to frequently audited, fiat-backed SCs like USDC, GUSD or BUSD

If the value of the cryptocurrency in the crypto-backed SC drops dramatically below the total value of the SC, what happens?
In the case of DAI, they will likely burn DAI to reduce its supply, therefore increasing its price although this is only effective up to a point. If you are uncomfortable with crypto-backed SCs, stick to a frequently audited, fiat-backed SC like USDC, GUSD or BUSD

I heard all this FUD about Tether, please tell me more
USDT was one of the first SCs ever created along with bitUSD and NuBits. You’ve probably never heard about the last 2 because they didn’t survive. USDT was always supposed to be fiat-backed and the Tether foundation has repeatedly stated that it maintained a 1:1 asset to USDT ratio. In Oct 2018, the price of USDT dropped below $1 (down to $0.88 at some point) and therefore lost its peg to the USD for a short period of time. The Tether foundation decided to burn (destroy) $500 million worth of USDT at that time in order to prevent any further downfall and restabilize the price of USDT back to $1. A month later, federal regulators started investigating the event as well as a hidden $850 million dollar loss by Tether’s parent company. What made matters worse was that Tether refused to allow an independent audit of its reserves/assets used to back USDT. It was later found that Tether was using a large portion of corporate bonds to back the value of USDT instead of using the more secure govt bonds, CDs and cash. There continues to be some concerns that Tether is not backing each USDT it issues with $1 worth of assets although a lot of the FUD on the topic is misplaced. If this scares you, then don’t buy USDT, stick to frequently audited, fiat-backed SCs like USDC, GUSD or BUSD.

You keep saying that you should stick to USDC, GUSD or BUSD, why?
They are all frequently audited (BUSD is audited every month) by large, reputable accounting firms. USDC and GUSD are also based in the US and under the purview of Federal and NYS regulators. They have never lost their peg to the USD. They maintain a diverse basket of assets just like VMFXX

What are some other risks of using fiat-backed SCs?

- They are often controlled by a central entity which controls its issuance (ex: GUSD is controlled by Gemini). You are trusting that this entity will continue to exist

- If the government seized or froze the assets backing the SC, you would lose money

- If the value of the assets backing the SC goes down, you will lose money (this is why it's important that the assets backing these SCs are safe, like US govt bonds)

- If the government decided to ban a specific SC like USDT, you would technically be able to recoup your money as long as it was properly backed 1:1 with real assets although this would likely be a nightmare to deal with

- If it was discovered that the SC issuer was printing more SCs than assets available to back it up, you would likely lose money

So why are we seeing such high returns on SCs? How come my savings account at Chase is giving me 0.01% returns while my Celsius account is yielding me 12% returns?

Short answer: we’re in a bull market and a lot of people are willing to borrow money in the defi space to play with crypto (dumb idea). Also, unlike defi lending platforms who like to share in some of the profits, Jamie Diamond likes to keep most of the returns to himself
Long answer: next section

The problem with traditional financial systems

For a long period of time, people in the crypto community have been shunned by the traditional finance community. For many years, people risked having their bank accounts shut down if they transferred money to centralized exchanges. Although that practice seems to have mostly subsided, it’s still incredibly hard to have traditional banks consider your crypto assets as something that has value and can be used as collateral

For example, let’s say you want to borrow some money so you go to Jamie Diamond and ask him for $1 million dollars. Jamie ain’t no fool so he wants you to post up some collateral. Jamie is also not down with crypto and doesn’t care than you have 20 BTC sitting in your Ledger wallet. He wants to see some real world assets or some cold hard cash. So now you have these people in the crypto space (some of them have millions or billions of dollars worth of crypto assets) who can’t borrow the amount of money they typically want from traditional banks. They’re stuck with a difficult decision:

They either continue to hold their cryptocurrencies (which they know will go up in value) but can’t borrow money from Jamie

Or

They sell their cryptocurrencies and lose any potential future returns but are can finally get that loan from Jamie


Ideally though, they would want to keep their crypto assets so they can continue to appreciate in value while also using them as collateral for a loan

Enter Defi

Cryptocurrency lending platforms realized this was an issue and saw the opportunity to enter the space. Someone is now able to borrow USDC from Celsius by posting BTC as collateral. However, the rules are strict:

-interest rates are much higher than in traditional finance, hovering around 15-20%+

-all loans have to be overcollateralized. That means if you want to borrow 500 USDC, you have to post up $1000 worth of BTC

-all liquidations are instantaneous

So let’s use an example. Let’s say the price of BTC is $60,000. You go to Celsius and want to borrow 30,000 USDC. They will require you to post up the 1 BTC as collateral. Your APR will be 20%, as long as you keep paying your monthly payment, you get to keep your loan (until it reaches its term). You can do whatever you want with that USDC now, can convert it to fiat and go buy a boat, can put a down payment for your house, can go and buy more BTC, it doesn’t matter. Now in a normal brokerage account, let’s say at Vanguard, if you are using margin and the value of your assets drops below your margin maintenance requirements, you get a nice email from Vanguard asking you to deposit more money. They give you 24 hours. They might even send you a reminder at the 12 hour mark or give you a call. If you don’t do anything, after 24 hours your assets are liquidated to recoup some of the loses. That’s not what happens in Defi. In the above example, if you borrowed 30,000 USDC and posted that 1BTC as collateral, the moment (and I really mean the moment) that the value of your BTC drops to $30,000, Celsius sells it immediately and recoups its 30,000 USDC. There are no warning emails or calls, no 24 hour windows to deposit more money, it’s an instant liquidation. Billions of dollars get liquidated in the crypto markets this way every time the market moves a few % points up or down. Borrowing money from these Defi platforms is very risky. However, the other end of the trade, where you are the one lending the money is fairly safe

So when you go to your favorite crypto lending platform and deposit your USDC, they will offer your 12% annualized returns. The reason why they can do this is because they lend it out for 20% and gives you part of that return. If the person that borrows your USDC has a drop in their collateral, their position is instantly liquidated before you can lose any money

Do I think these rates will continue to be this high?
No. We’re in a bull market where people are willing to borrow at these crazy rates because they don’t want to sell their crypto. As more and more people get liquidated from these swings and as the bull market comes to an end, these double digit returns on your SCs will also come to an end. But please remember, even though your rate of return might come down, the risk of you losing your assets is extremely low

12% is so high! Where’s the risk, who’s taking the risk and where is all this money coming from?
It’s coming from the degenerates that are borrowing $100,000 in order to go all in on SHIB at the height of the pump and dump scheme and get instantly liquidated

This got a little bit too long and I also didn’t get to go into some other topics I wanted to discuss. Hope this is helpful to at least 1 person. I’m looking forward to all your comments, including:

“The words stable and crypto don’t belong in the same sentence, crypto is the devil’s creation and will go to 0 in the next few months, just wait and see”

“GUH, why so long, where TL;DR?” Fine TL;DR: Stablecoins are cryptocurrencies that are pegged to the USD and maintain a $1 value at all times. They are the crypto equivalent to money market mutual funds. They have large % returns at this time because we're in a bull market and there's a lot of degenerates that are willing to lose money

[jacoavlu]

i learned something from this, thanks for the writeup. i don't have much interest in the defi space in general so I've never dove into any of this besides doing some due diligence around the more common stablecoins and the blockfi type platforms

i would point out the loan interest rates aren't always that high. at celsius you can get a loan at 1% / 7% / 9% for LTV of 25% / 33% / 50%

[bovie]

This very interesting. Maybe help me some day. Windowlicker appreciate.

[CordMcNally]

Ok listen up windowlickers, mouthbreathers and nocoiners alike.

Great start. To be fair, I understand it was probably in jest to somewhat mimic the overall attitude of something along the lines of r/WSB but how many people do you expect to keep reading after that start? That's pretty much the end of my 'old man' rant.

[xraygoggles]

Pretty good synopsis of the stablecoin sphere. Good that you pointed out that the yield will decrease when demand to borrow dissipates after bull run.

[Jaqen Haghar MD]

Great information. Thanks.

Can you imagine a set of circumstances that would result in the catastrophic failure of the system of stable coins? All systems and assets have catastrophic failure scenarios.

It’s sounds like what you are describing, in a nutshell, is that high interest rate yielding stablecoins are able to pay high interest rates because the money is being used to fund highly (crypto) collateralized margin loans at very high interest rates elsewhere.

A good percentage of these loans are probably being used to buy more crypto currency, along with depreciating consumer goods.

Some might consider this set up to contain certain elements of individual and systemic risk.
But hey, without risk, there is no yield.

[jacoavlu]

Great information. Thanks.

Can you imagine a set of circumstances that would result in the catastrophic failure of the system of stable coins? All systems and assets have catastrophic failure scenarios.

It’s sounds like what you are describing, in a nutshell, is that high interest rate yielding stablecoins are able to pay high interest rates because the money is being used to fund highly (crypto) collateralized margin loans at very high interest rates elsewhere.

A good percentage of these loans are probably being used to buy more crypto currency, along with depreciating consumer goods.

Some might consider this set up to contain certain elements of individual and systemic risk.
But hey, without risk, there is no yield.

important to understand the mainstream stablecoins themselves have no inherent yield. just like a dollar. the yield / lending / borrowing is a separate thing, and is not unique to stablecoins

there are plenty of catastrophic failure scenarios. as discussed in another thread I think the risk of the stablecoins themselves collapsing is very low. those entities are regulated and audited and have been around a while

the greater risk is in the lending etc platforms. not all of them are highly transparent with what they're doing with assets deposited to the platform. they could be rehypothecating assets. they could get hacked and have customer assets stolen. they could fat finger some important code entry and just straight up screw something up.

the risk is much higher in the more frontier defi stuff. there are rug pulls and lost funds in those spaces commonly. mark cuban was famously crying about losing some funds pretty recently

[nycEMMD]

i learned something from this, thanks for the writeup. i don't have much interest in the defi space in general so I've never dove into any of this besides doing some due diligence around the more common stablecoins and the blockfi type platforms

i would point out the loan interest rates aren't always that high. at celsius you can get a loan at 1% / 7% / 9% for LTV of 25% / 33% / 50%

That's a good point, haven't checked rates recently, 6% APY for depositing USDC on Celcius, 9% APR for borrowing at LTV of 50%. Thanks

[nycEMMD]

Great start. To be fair, I understand it was probably in jest to somewhat mimic the overall attitude of something along the lines of r/WSB but how many people do you expect to keep reading after that start? That's pretty much the end of my 'old man' rant.

Yeah, kind of forgot where I was for a second. Sometimes you just have to get past that first sentence though

[jacoavlu]

That's a good point, haven't checked rates recently, 6% APY for depositing USDC on Celcius, 9% APR for borrowing at LTV of 50%. Thanks

USDC currently paying a hair over 10%.

also important to note that if you have collateral posted there, assets locked up as collateral no longer earns interest.

[Nysoz]

This is a house of learned doctors.

[nycEMMD]

Can you imagine a set of circumstances that would result in the catastrophic failure of the system of stable coins? All systems and assets have catastrophic failure scenarios.

Detailed a few above for individual stablecoins or different categories of stablecoins. Only way all of them would fail simultaneously is if there is a complete collapse of the financial system, including the assets that back these stablecoins. Another alternative would be if all countries simultaneously ban stablecoins. Otherwise, I think single points of failure for each stablecoin exist, everything from the company that issues them going under, to regulatory risk, to its underlying assets being stolen/seized/frozen

It’s sounds like what you are describing, in a nutshell, is that high interest rate yielding stablecoins are able to pay high interest rates because the money is being used to fund highly (crypto) collateralized margin loans at very high interest rates elsewhere.

A good percentage of these loans are probably being used to buy more crypto currency, along with depreciating consumer goods.

This doesn't really affect fiat-backed stablecoins but it does affect the crypto markets in general. Take USDC for example. It is frequently audited, it continues to maintain a reserve of assets that has the same value as the amount of USDC in circulation. If the crypto markets suddenly crash and there is a massive deleveraging scenario, USDC should technically not be affected as every single USDC is backed by $1 worth of USD or USD equivalent security like US govt bonds.

The large amounts of borrowing and lending in defi definitely affects the crypto markets in general by making swings to the upside and downside more pronounced. If you take the scenario in the original post, as the price of BTC goes down to 30k, that trader gets liquidated and their BTC gets sold. As this happens to thousands of traders, lots of BTC get sold which drives the price down further and liquidates other traders. It amplifies sell offs but also amplifies rallies. All this may have an effect on crypto-backed SCs and algorithmic SCs but shouldn't have much of an effect on fiat-based SCs like USDC, GUSD, BUSD

[nycEMMD]

USDC currently paying a hair over 10%.

For some reason I'm seeing 6%, interesting....

also important to note that if you have collateral posted there, assets locked up as collateral no longer earns interest.

Yup, very good point, you can't double dip. Anything you use as collateral for a loan no longer earns you interest

[jacoavlu]

For some reason I'm seeing 6%, interesting....



Yup, very good point, you can't double dip. Anything you use as collateral for a loan no longer earns you interest

https://celsius.network/rates/